Question

1.Why do managers want to minimize the cash conversion cycle?

2.Explain the relationship between the EOQ and the CCC?

Answer 1

1.Managers want to minimize the cash conversion cycle due to the following reasons:

1. Accounts Receivable: The aim of the managers is to recover its money faster as the faster a company receives the payment for the goods sold or the services provided itiis better for the organization. It is not ideal for any organization to have       a large outstanding balance in the form of accounts receivable. Though an accounts receivable is an indication of the profitability that arises in the future , but it can be truly effective only when it gets converted into cash. A short collection time is a depiction of efficient management.
2. Accounts Payable: The aim of the managers is to reduce the cash conversion cycle by paying the suppliers or the accounts payable later. The managers will still ensure that all payments towards the accounts payable are made as per the terms on which the contract had been negotiated as the managers would be aware that there may be no benefit resulting from an early payment . Therefore managers will work towards increasing the cash on hand and thereby set up a payables management system which ensures that all payments are made as close to the due dates as possible.
3. Improving the bottom line favourably: A shorter cash conversion cycle increases the company’s bottom line favourably due to the significant savings that the organization has made.
4. Wooing Lenders: Organizations having a shorter cash conversion cycle may not necessarily have unlimited funds and may find themselves in a situation where they may need funds for the purpose of meeting any unforeseen expenses , making an investment , for taking advantage of growth opportunity. To tide over this problem they need to go in for borrowings from lenders. The managers will aim for a shortening of the cash conversion cycle because lenders would take this into consideration while taking decisions on the amount of loan, rate of interest to be charged etc as a shorter cash coversion cycle reflects on the early recoverability of their loans.           

2. Relationship between EOQ and CCC:

EOQ is a production formula that projects the most efficient amount of goods or inventory that should be ordered or purchased so that the organization is able to minimize the costs associated with the ordering and the handling of the products. EOQ is extremely effective for the managers in an organization as it guides them in understanding the optimal quantity of the goods or inventory that the organization should hold on hand as well as information on when to order so that they can meet the demand for their products as and when it arises and also thereby increasing the cash holding that arises due to the minimization of the ordering and holding costs.

Adopting EOQ leads to the organization having an optimum amount of inventory to avoid stock outs resulting in lost sales and thereby not tying up funds unnecessarily to the inventory and thereby managing its inventory effectively leading to a shortening of the cash conversion cycle.

Therefore an efficient EOQ model has an effect on the shortening of the cash conversion cycle. Managers will equate cash to inventory and thereby extend the EOQ model to understand its implications on the cash management .